You have a 30-year old client who has inherited $1,000. The inheritance stipulation requires that your client
Question:
You have a 30-year old client who has inherited $1,000. The inheritance stipulation requires that your client invest in either Grand Frommage stock or a Savings Account earning 5% a year. The investment must be held for five years. Key information: The S&P 500 is expected to return 10% over the next five years. No change in the economy is expected that will positively or negatively impact Grand Frommage's performance. The price per share of Grand Frommage is $1,000 and the company expects to pay a $95 dividend next year. The dividend growth rate over the last two years averaged 2% and averaged 5% the five years prior to that. The expectation is that over the next five years Grand Frommage's dividend growth rate will be similar to the last two years. Grand Frommage has a beta of 1.25.
a. Using CAPM, what is the required return for your client? Show all work.
b. Using the Dividend Growth rate model, what is the value of Grand Frommage stock? Show all work.
c. Is the current stock price over or undervalued based on the answer from (b) above? Show all work.
d. Should your client invest in Grand Frommage solely based on the information from (c)? Show all work.
e. Would your answer change from part (d) if your client has no net worth and a $1,000 student loan due in exactly five years? Why?
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill